IOSCO Expresses Concerns on "Credit Sensitive" LIBOR Replacements

Commentary by Nihal Patel

IOSCO said that two "credit sensitive" alternatives to USD LIBOR should not be represented as being "IOSCO-compliant."

In a statement on alternatives to USD Libor, IOSCO identified "varying degrees of vulnerability" among four different Libor substitute rates as to their implementation of IOSCO's 2013 Principles for Financial Benchmarks. Two of the rates reviewed were "credit sensitive rates" ("CSR") and two were Term SOFR rates. IOSCO's review found that the credit-sensitive rates "exhibit some of the same inherent 'inverted pyramid' weaknesses as LIBOR" and that "[a]bsent modification, their use may threaten market integrity and financial stability." IOSCO said that administrators of the rates, as well as their auditors and consultants, should not represent that the rates are "IOSCO-compliant." IOSCO made clear that despite the conclusions of its review, market participants that have referenced CSRs in contracts may continue to offer them going forward but should "proceed with caution."

IOSCO said that the Term SOFR rates "fell short of SOFR" and "are suitable for limited use only." Echoing previous statements by the Alternative Reference Rates Committee and the United Kingdom Working Group on Sterling Risk-Free Reference Rates, IOSCO said that if Term SOFR usage were to become too widespread at the expense of underlying SOFR markets, the Term SOFR rates would be undermined.

Commentary

While not mentioned in the statement, it is widely known that the credit-sensitive rates being reviewed were Bloomberg's Short-Term Bank Yield Index (BSBY) and American Financial Exchange's Ameribor. The statement is obviously bad news for market participants seeking to use the rates. However, IOSCO does not have the power of direct regulatory oversight. Instead, it remains up to local regulators to determine whether to echo the statement and push against their use, and in particular (at least in the United States), whether banking regulators take action, given that a good number of regional banks have, for years, pushed for the ability to use credit-sensitive rates over SOFR.

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